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Fiscal allocations and income tax changes are always considered as the cornerstones of any budget, but as a fund, we were intrigued if an attempt would be made at normalizing tax rates between different asset classes.
Equity markets have had a good run in the recent past, and an unintended outcome of that has been diversion of funds into equities. Deposits as a percentage of net worth has gone down, so much so that even the RBI Governor had to step in to point the trend. Short-term taxation has now been increased from 15 percent to 20 percent and an effort has been initiated at making the tax differential more equitable between debt and equity, but time will tell if the same would be enough to alleviate pressure on deposits.
Arbitrage funds get advantage of equity MFs, even though they were in essence debt funds as the risk profile is comparable. The gap between arbitrage and debt taxation has been somewhat bridged. The huge allocation and inflow that had happened in arbitrage funds because of this tax arbitrage should weaken at least, and that should also help for they directly compete with deposits. The last 15 months saw the arbitrage category grow from Rs 50,000 crore to Rs 2,00,000 plus crore and the trajectory may have got controlled with STT (Securities Transaction Tax) and short term tax changes.
Long-term equity taxation has been roughly untouched, increasing from 10 percent to 12.5 percent should not affect sentiment much, and for the right reasons. Equity markets do carry significant risk and investor reward left almost as it is for bearing associated uncertainties. Deposits play a very important role in overall economic well being, and the Chief Economic Advisor had rightly pointed out the risks if financial innovations run ahead of time. The new STT and short term taxation rules should bring some moderation back and curb some of the volume that has been happening in derivatives segment.
While no systemic risk exists in derivatives, because the market works on margin money that is deep enough to cover sigma events, high retail participation was bringing in its own set of challenges. While systemic risk is plugged, retail investors could individually make loss and an attempt has been made to discourage very short term risk taking tendencies.
The Prime Minister himself had indicated that the Budget would set tone for 3.0 and we broadly believe that fiscal prudence has been maintained and allocations made as per what markets had been sensitized to.
Asset tax adjustments are something which we feel that the policy makers will need to tackle sooner than later to best balance the liquidity out, but otherwise policy continuity and certainty will now ensure focus shifts back to micro management and matrices in nation building.
(The article was first published on Moneycontrol)